Six biggest pitfalls in business banking offer letters

Neil Slonim

You might be surprised by how many business owners actually accept an offer letter from their bank without fully understanding all the clauses. Arguing the toss with a bank after the event is not a smart move. Admittedly, it’s not easy for non-bankers to grasp the complexities of bank terminology but ultimately the onus rests with you to understand exactly what you are signing up for. The most common and expensive pitfalls borrowers fall into when signing bank offer letters are misunderstandings, discussed below.

1. Security especially personal guarantees

Despite requirements to obtain legal advice before signing a guarantee, this area remains a source of great angst and financial stress for many guarantors especially in situations involving business partners and non working spouses and family members. It is critical to understand the various types of guarantees and the rights of the bank to call on your guarantee.

2. Margins and fees

There are numerous components which go to make the all up cost of borrowing including base rates, margins, line fees, utilisation fees, unused fees, facility fees, reference fees, undrawn fees & drawdown fees to name just a few. What might on the surface look like an attractive deal could prove to be just the opposite when you really understand all the fees.

3. Expiry and review dates

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Loans must be repaid on or before the expiry date. The bank is under no obligation at all to continue to support you. Your bank could refinance the old loan with a new one but increasingly banks are electing to re-coup their capital and then lend it out to other parties considered safer risks. A review date is slightly different in that it gives the bank the right to decide whether it wants to continue to provide the loan. The review process affords the bank the opportunity to ask for the loan to be repaid depending on performance hurdles and other clauses in the offer letter such as “material adverse changes”. Obviously you want to have as much certainty as possible that the bank can’t and won’t pull the loan prior to expiry.

4. Break costs and prepayment clauses

You can get caught out by break costs or prepayment fees if you want to pay back the loan prior to expiry, especially if you have fixed rate or swap arrangements in place which will need to be unwound. Such costs can be so significant as to make repaying/refinancing financially unpalatable. So don’t consider prepaying a loan without being fully aware of any break costs.

5. Definitions of covenants

A slight misunderstanding of the definition of a covenant could see you in breach of the offer letter. Examples might be how shareholders loans or intangible assets are treated when defining “net tangible assets” or whether lease payments or amortisation are included in the definition of “financial commitments”.

6. Events of review and default

Most offer letters will have events of default and some will also have events of review. As with “expiry and review dates” above, there is a big difference between the two. Try to negotiate for the latter as an event of review will allow you more time to convince the bank that you have things under control. A default on the other hand gives the bank the right to immediately call in your loan or appoint an agent to take control of your business.

Key lessons

Unfortunately due to blind trust, ignorance or time pressures some business owners sign bank letters of offers without fully understanding the contents. Its always worthwhile to have an expert like an accountant or lawyer review the letter before you sign it and if you don’t understand any aspect of the offer don’t sign it!

You should be able to trust the verbal and written representations made by your bank but you should also carry out your own due diligence to ensure you actually understand and agree with the bank’s representations. “Trust but verify”.

Neil Slonim is an independent business banking expert. He is the founder of theBankDoctor.com.au an online resource centre designed to help SMEs understand, quantify and mitigate their Bank Risk which he defines as "the risk of the bank not being there for you in your time of need". Website www.thebankdoctor.com.au Twitter @NeilSlonim